Price Impact and Survival of Irrational Traders

Leonid Kogan, Stephan Ross, Jiang Wang and Mark Westerfield ()
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Stephan Ross: Sloan School of Management, MIT and NBER
Jiang Wang: Sloan School of Management, MIT and NBER

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: Milton Friedman argued that irrational traders will consistently lose money, won’t survive and, therefore, cannot influence long run equilibrium asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact are two independent concepts. The price impact of irrational traders does not rely on their long-run survival and they can have a significant impact on asset prices even when their wealth becomes negligible. We also show that irrational traders ’portfolio policies can deviate from their limits long after the price process approaches its long-run limit. We show, in contrast to a partial equilibrium analysis, these general equilibrium considerations matter for the irrational traders long-run survival. In sum, we explicitly show that price impact can persist whether or not the irrational traders survive.

Date: 2004-10
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Related works:
Journal Article: The Price Impact and Survival of Irrational Traders (2006)
Working Paper: The Price Impact and Survival of Irrational Traders (2004)
Working Paper: The Price Impact and Survival of Irrational Traders (2003)
Working Paper: The Price Impact and Survival of Irrational Traders (2003)
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